Office Struggles Persist; Cushman Takes Lead
Large office sales in the first half tumbled to a low not seen in more than a decade as headwinds continued to batter the beleaguered sector, dashing hopes for a quick recovery.
In the first six months, just $15.34 billion of office properties valued at $25 million or more changed hands, a 67% decline from the same period in 2022, according to Green Street’s Sales Comps Database. That’s the weakest first half recorded since 2010, when sales dipped to $10.41 billion in the aftermath of the global financial crisis.
The top five brokerages all registered substantial drops in brokered deals, scram- bling the typical lineup of rankings at the midway point. Cushman & Wakefield landed in first place with $2.43 billion of sales, down 66% year over year, while JLL, in second, saw a 72% fall in activity to $2.08 billion. CBRE, which typically jock- eys for first place, narrowly placed third with $1.86 billion of trades, an 82% drop. Newmark came in fourth, with $1.85 billion of trades (see article on Page 13), while
Eastdil Secured, also a perennial contender for the top spot, tumbled to fifth with $1.61 billion of sales. Both firms’ activity was down 79% versus the first half a year ago.
The conditions that started the slump last year continue to weigh on the sector, namely cloudy leasing demand and scarce and costly debt. Those factors have pushed the asset class out of favor with buyers and made valuing office properties nearly impossible. Pros believe there will be a recovery — but it will take time.
“This is the storm of the century for office,” said Doug Harmon, co-head of U.S. capital markets for Newmark. “Values are resetting, and until there is more clarity on all the variables negatively impacting the asset class, trading volumes will remain muted. If the economy stays resilient, inflation is tamed and interest rates stabilize — all of which are now probable — then the death of office will have been greatly exaggerated and trading of repriced office assets will return with gusto.”
But no one expects those issues to be resolved this year, meaning the second half also likely will be slow for sales activity. For now, “we are bouncing on the bottom,” said Chris Ludeman, CBRE’s global president of capital markets.
Deals that did cross the finish line in the first half tended to be smaller than usual. Nationwide, just 243 office transactions closed from January through June, nearly a third of the 733 deals that wrapped up during the first six months of 2022, according to the database. Just 38 deals valued at $100 million or more traded in the first half, compared with 116 last year. Only four sales surpassed $500 million as of June 30, down from 14 during the first six months of 2022.
The first half was also the first January-June period since 2012 when the average deal size slipped below $100 million, according to the database. The average transaction in the first six months was $84.7 million, down from $113.6 million during the same period last year. The 10-year peak came in the first half of 2021 at $121.6 million.
Ludeman likened the sector’s expected trajectory to that of retail — when the rise of e-commerce sent a seismic wave through the industry, stifling property sales for years. Similarly, office owners are adjusting to systemic changes in leasing demand stemming from the sticky work-from-home trend that took hold during the pandemic. Investors and lenders won’t return until that improves. “The [performance] fundamentals will lead us to a better day, but that is not today,” Ludeman said.
The leasing market started to show signs of improvement in the second quarter, though overall occupancy still dropped. “There are quite a few green shoots,” said Mark Katz, a senior managing director and co-head of JLL’s national office-invest- ment sales group. He said more firms are moving workers back to offices, which should eventually spur leasing demand.
While net absorption in April through June remained negative nationwide, as tenants vacated 12.5 million sf of space, that was down from 20 million sf vacated in the first three months of the year, according to JLL. While leasing activity was insufficient to cover the growing vacancy, it was up 11.6% in the second quarter over the first.
The lack of clarity surrounding the performance of office properties has prompted lenders to shy away from originating debt on all but the most core, trophy assets. The upshot: “Almost every transaction has to be [financed with] existing financing or seller financing,” JLL’s Katz said. “Until the debt markets recover, we are not going to have a recovery [in office sales].”
That also means a continued lack of visibility on valuations.
As the hardest hit asset class since the start of the pandemic, “there is much debate with regard to how much office values have fallen thus far and how much more they may have left to fall,” Green Street, the parent of Real Estate Alert, said in a July report.
Those sales that are happening are largely the result of distress, when owners unable to refinance or fund capital improvements to boost leasing are forced to cooperate with lenders to exit investments. In other cases, they sell properties to raise liquidity to address other balance-sheet issues. For the handful of players still active in the space, that spells opportunity.
“We can start to buy income again at higher yields and lower risk,” said Joe Gorin, a managing director and head of U.S. real estate equity at Barings. Capitalization rates have increased to a point where a high-quality property can potentially stabilize above 10%. “We haven’t talked about double-digit NOI yields in office buildings since the mid-1990s,” he said.
His company closed on one of the few sizable trades of the first half, paying Alexandria Real Estate Equities $117.5 million, or $231/sf, last month for Riverside Center, a 510,000-sf office and life-science complex in the Boston suburb of Newton.
Buyers are being highly selective, focusing on properties perceived to check all the boxes that tenants require today. “You have to be very careful about what you buy at this time,” said Craig Deitelzweig, chief executive of Marx Realty. “It’s the most bifurcated [leasing] market I’ve ever seen in my lifetime. If you are not a good property with the types of amenities that tenants want, you won’t lease at any price.”
Against that backdrop, nearly every market saw a drop in sales volume. New York, the perennial leader in office sales, registered $3.02 billion of trades, down 56% year over year, followed by Boston with $2.04 billion of activity, down 45%. Washington, where early distressed buying opportunities have started to arise, was in third, with $1.23 billion of sales, a 57% decline.
West Coast markets, which had been popular with investors in recent years due to their heavy concentrations of technology- focused companies, took a beating. Sales in San Francisco were down 71% to $433.3 million, while Seattle saw just one property trade, at $34.5 million, a steep drop from $2.83 billion of total volume the year before, pushing it out of the top 20 markets altogether.
Not even Sun Belt markets, heavily favored by investors ear- lier in the pandemic due to population growth and company migration, were spared. Only Austin managed to place in the top 10 markets with $382 million of sales, a decline of 73%.
This year’s office ranking did not include sales of data-center properties, which totaled $533.6 million, down from $1.09 billion last year. CBRE dominated the niche sector with $447.3 mil- lion of trades, good for a 91% market share of brokered sales.
Broker rankings are based on property transactions that closed January through June and involved full or partial stakes valued at $25 million or more. When multiple brokers shared a listing, the dollar credit was divided evenly, but each broker was credited with one transaction. Only brokers for sellers were given credit. Portfolio transactions were included if the package price was at least $25 million.
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